Make-work schemes are not going to save us

The burst property bubble and the resulting banking and sovereign debt crises have created more than a financial disaster. After a decade of almost full employment, the demand for labour in Ireland has collapsed and employment is still falling. But the pattern of employment decline, especially since the implosion of the banking system and the commencement of fiscal austerity towards the end of 2008, displays some disturbing features.

From the final months of 2008 to the last quarter of 2010, total employment in Ireland fell by 230,000, led by construction, where employment halved in just two years with total job losses of 105,000. There were extensive job losses also in manufacturing and most of the services sector. But three sectors managed to hold total employment steady, the sectors called public administration, education and health in the labour market statistics.

Most of the people engaged in these sectors are employed directly by the State, and the remainder, although not formally public servants, are employed by institutions reliant on state funds to a substantial degree.

A total of almost 489,000 people were employed in these three sectors at the end of last year, virtually unchanged from two years earlier. About 350,000 of these are direct state employees.

All of the other economic sectors combined have seen employment fall by about 15 per cent in the two years. This is a massive adjustment in a very short space of time, and the contrast in the employment figures between the various sectors is striking. There were 3.2 workers engaged in the general economy for every person engaged in administration, health and education at the end of 2008. This has now dropped to just 2.7.

Public administration is necessary, of course, and the health and education sectors provide valued services. But this pattern of developments is unbalancing the economy. It is universally conceded that Ireland must somehow export its way out of the current economic crisis. There are very limited export possibilities in the three sectors where employment has held up and growth must come elsewhere. This needs a concerted effort to improve competitiveness in the internationally traded sectors, particularly in manufacturing, export services, tourism and hospitality.

There is an air of defeatism about the prospects for job growth in traditional manufacturing, with people apparently intimidated by the scale of the competitiveness gap against China and other emerging industrial powers. But the Chinese industrial surge started in 1980 and several European countries have succeeded in creating extra manufacturing jobs subsequent to China's re-entry into the world economy.

One of those countries happens to be Ireland: during the decade up to 2001, when industrial employment peaked in this country, Ireland added 70,000 industrial jobs. Chinese competition was already a factor during those years. Several other European countries, notably Germany, have enjoyed manufacturing success notwithstanding the emergence of Asian competition. What went wrong in Ireland was a steady loss of competitiveness over the last decade. It started back around the year 2000 and was widely bemoaned along the way, notably in the annual reports of the National Competitiveness Council.

The bubbles in construction and in public expenditure through the Ahern years pushed up costs for the traded sector and manufacturing employment was a casualty. A domestic credit bubble, which stimulates construction, public spending and consumption, pulls up costs all round and damages the exporting businesses.

Since it must now be accepted that there will be further job losses in sectors like construction and retail banking, the patterns of recent years must be reversed. This means a consistent policy across Government of forcing down the cost structure of export manufacturing, not just focussed on payroll costs but also on utility charges, property costs, local authority charges and professional fees.

The same policy approach will help in the export services area, where some Irish indigenous companies appear to have weathered the storm well over the last few years. If the cost base is right, there is no reason why employment should not grow.

In tourism and hospitality, there is clearly an excess of capacity, evidenced by the large number of under-utilised hotels and half-empty airport terminals. The tourism industry appears to have responded with cost-cutting and price reductions, particularly in the accommodation sector, where government tax incentives helped to create a hotel-building bubble. It is surely better to see if we can fill the hotels, at lower prices, rather than consign them to some kind of scrappage scheme.

The recent visits from Queen Elizabeth and Barack Obama have been a big boost and the Government has dropped the travel tax, which surely makes sense given the excess of capacity.

The Queen appears to have been a quite willing participant in what was virtually a tourism promotion video for Ireland. The decline in inbound tourism can surely be reversed as the economies of source markets recover.

In opposition, both Fine Gael and Labour railed against the sharp rise in unemployment and stressed the need for job creation. Recent initiatives from the new Government have included some extra funds for road maintenance and schemes for better home insulation. A motivating factor is clearly the re-employment of some workers displaced from the construction sector. There may be worthy projects in these areas but there is a problem: we cannot export better-insulated homes, or filled-in potholes.

The temptation to pursue make-work schemes is a political constant when unemployment is so pressing, but durable job creation, based on an internationally competitive cost base for the traded sector, is the only sustainable path to a healthier labour market. We have done it before. Borrowing money to finance temporary labour-intensive schemes is not a serious policy alternative, since we cannot increase borrowing. Schemes that are budget-neutral must be accompanied by expenditure cuts or tax increases elsewhere, which are destructive of job creation in unseen ways.

A good example is the stealth tax on the private sector in the form of the pension levy, which was used to finance the recent jobs initiative. This can only create an additional burden on the sectors of the economy which promise sustainable jobs potential based on exports, while exempting the sectors of the economy which do not.

Not everyone who is out of work, many displaced from construction, can expect to re-emerge as hi-tech wizards. Of course the hi-tech sector and the creation of opportunities for college graduates should be a priority but most of the recently unemployed are blue-collar workers.

Someone who has been driving a dumper on a building site can readily find compatible jobs in manufacturing. People displaced from retailing or banking can re-route into the hotel business.

There is something of a middle-class bias about the excessive concentration on hi-tech and too ready an acceptance of the notion that employment for graduates is all that matters.

There is some evidence that competitiveness is being restored in the traded sector, but it has not been happening quickly enough to arrest the jobs decline. While unemployment is no longer rising so rapidly, it is clear that emigration is the main explanation. Government needs to address all measures available to accelerate the competitiveness gains.

The Government is committed to changing the system of upward-only rent reviews, which should help contain property costs. Richard Bruton's proposals to reform the archaic system of pay determination in parts of the economy are important in this regard but must be set against the mistaken decision to increase the minimum wage to a 25 per cent premium over the UK figure.

Remuneration levels across the board, from top-level pay of senior executives to the wages of less-skilled workers, have drifted out of line with what can be afforded. As pay rates in the traded sector of the economy are brought into line with the needs of job-creation, the same must happen with remuneration in the sheltered sector, including public services.

In an open, trading economy, given that payroll dominates business costs, restoring a healthy jobs market means lower pay all round.

There is a politically awkward consequence of lower pay for those in employment, particularly when taxes on earned income are rising sharply. A balance must be maintained between post-tax earnings from employment and (untaxed) income from the social welfare system. If post-tax earnings from employment have been falling and must fall further, this needs to be reflected in rates of entitlement under the social protection schemes.

Colm McCarthy lectures in economics at University College, Dublin. He has headed an expert group examining state assets and chaired the Special Group on Public Service Numbers and Expenditure Programmes, aka An Bord Snip Nua. He is also the author of the report into the semi-state sector from the Review Group on State Assets and Liabilities